The importance of a Unified Approach on tax and the digitalised economy

Achieving global consensus on changes to the international tax system and digital economy would be a considerable prize. I believe it is a lot closer following a major announcement from the Organisation for Economic Cooperation and Development (OECD), on Wednesday night, Australian time.

The Secretariat of the OECD’s Task Force on the Digital Economy released a consultation document for a Unified Approach in modifying the current international business tax rules to address the digitalisation of the global economy. A unified future would be much better than the alternative of many countries introducing their own Digital Services Tax (DST) – which are poor taxation mechanisms and hang like a Sword of Damocles over the deliberations of the OECD’s Inclusive Framework of more than 130 countries.

I believe the prospect of a proliferation of DSTs give the OECD’s proposals a decent chance of being successful – maybe a 60-80 percent chance. There is much to do but business needs certainty, and would generally accept the risk of an increased global tax liability in return for that certainty. It does not want an overly complex solution, as some of the earlier recommendations in this process suggested.

The fact the OECD has published this consultation document is an indicator it may have a certain level of broad support across the Inclusive Framework members. There is a sense that finance ministers want the matter dealt with.

The goal is to find a solution where there are not big winners and big losers in any reallocation of taxing rights.

While plenty of detailed issues require resolution before the members of the OECD Inclusive Framework can reach an overall agreement, the above factors combine to make success much more likely.

The Unified Approach is open for public consultation, with submissions closing on 12 November. The objective remains to achieve a solution acceptable to all countries before the end of 2020, with this solution then expected to take at least two years to implement.

The key features

The OECD Secretariat’s consultation document calls for public input on the scope for the Unified Approach, including whether to limit it to those businesses that are subject to country-by-country tax reporting rules (broadly, A$1 billion global group turnover). Importantly for Australia, extractive industries and certain financial services may fall outside the scope of the Unified Approach, although this will doubtless be the subject of considerable international debate.

The Unified Approach’s most dramatic feature is that some of the “residual profit” of a multinational would be able to be taxed in market jurisdictions, even where the multinational had no taxable presence there under current rules. This would work as follows:

The residual profit would be the profit remaining after applying a globally-agreed deemed routine return on a multinational enterprise’s activities.

The above calculation could occur by business-line, for multinational enterprises with segmented reporting.

Taxing rights over a portion of the deemed residual profit would then be reallocated among market countries based on a simplified allocation key (for example, value of sales).

The balance of the residual profit would continue to be taxed in the jurisdiction where it is generated (subject to a potential global minimum tax rule, about which the OECD intends to release a further consultation document in November).

The Unified Approach would also see market jurisdictions taxing the return on so-called baseline distribution and marketing activities, where these are carried out by a subsidiary or physical permanent establishment of a multinational enterprise within the jurisdiction. The consultation document advocates using globally-agreed fixed rates of return to calculate this taxable amount, perhaps on an industry basis, as a way of reducing transfer pricing disputes.

The market jurisdiction would also have the right to tax the additional return, calculated under current transfer pricing rules, on any local “beyond-baseline” activities.

So, where a multinational enterprise sells into market jurisdiction Z, Z would tax its share of residual profit based on the allocation key. If the enterprise carried out baseline activities through a physical presence there, Z could tax the return on those activities also, possibly according to a globally-agreed formula. If the enterprise carried out beyond-baseline activities through that physical presence, Z could also tax the return on those activities, following current transfer pricing principles.

The publication of the proposal for the Unified Approach is a positive step towards achieving international consensus. It is to be hoped that the forthcoming public consultation will produce a wealth of constructive and practical input, in order that progress can accelerate from here. Such acceleration is necessary if the goal of a consensus solution by the end of 2020 is to be achieved.